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The Restatement of the Business Judgment Rule: The Question of Rationality

Regular readers know I am working on a couple of projects dealing with the forthcoming Restatement of the Law of Corporate Governance. Not everything I think about the restatement will make it into a law review article, but they will make great blog fodder.

To with, the drafters have restated the business judgment rule in section 4.02 as follows (in pertinent part):

A director or officer who makes a business judgment is not liable to the corporation or its shareholders if the director or officer: ... (4) rationally believes that the business judgment is in the best interests of the corporation.

Reporter's Note 1 to that section explains that:

Delaware incorporates the fourth component of the black letter by explaining: “where the business judgment presumptions are applicable, the board’s decision will be upheld unless it cannot be attributed to any rational purpose.” . . . A line of cases decided under Delaware law support the test that under the business judgment rule, a corporate decision will be upheld unless it cannot be attributed to any rational business purpose.

I agree with everything the drafters say. But I would like to add a friendly amendment, which I hope they will consider incorporating into the text. I take the following from Stephen M. Bainbridge, Corporation Law and Economics (2002), at 274-75:

In Sinclair Oil Corp. v. Levien, the Delaware supreme court held that so long as the board’s decision could be attributed to any rational business purpose the business judgment rule precluded the court from substituting its judgment as to the merits of the decision for those of the board.[1] Similarly, in Brehm v. Eisner, the court held that the business judgment rule does not apply when the board has “act[ed] in a manner that cannot be attributed to a rational business purpose.”[2]

The reference to a “rational business purpose,” properly understood, does not contemplate substantive review of the decision’s merits. As Professor Michael Dooley observes, “Sinclair’s use of [the word] rational is to be equated with conceivable or imaginable and means only that the court will not even look at the board’s judgment if there is any possibility that it was actuated by a legitimate business reason. It clearly does not mean, and cannot legitimately be cited for the proposition, that individual directors must have, and be prepared to put forth, proof of rational reasons for their decisions.”[3] Consequently, as Chancellor Allen has stated:

[W]hether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule—one that permitted an “objective” evaluation of the decision—would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests.[4]

Instead, as Chancellor Allen observed elsewhere, “such limited substantive review as the rule contemplates (i.e., is the judgment under review ‘egregious’ or ‘irrational’ or ‘so beyond reason,’ etc.) really is a way of inferring bad faith.”[5]

Put another way, inquiry into the rationality of a decision is a proxy for an inquiry into whether the decision was tainted by self-interest. In Parnes v. Bally Entertainment Corp., for example, the Delaware supreme court stated that: “The presumptive validity of a business judgment is rebutted in those rare cases where the decision under attack is ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’”[6]In that case, Bally’s CEO allegedly demanded bribes from prospective takeover bidders and, moreover, allegedly received such a bribe from the successful bidder. In holding that the plaintiff shareholder had stated a cause of action, the court observed that “it is inexplicable that independent directors, acting in good faith, could approve the deal” when it was so tainted.

Litwin v. Allen is often cited as an exception to the foregoing proposition.[7] Put another way, Litwin supposedly creates an “incredible stupidity” exception to the business judgment rule. Under this reading of the opinion, it stands as an example of a board decision so irrational as to not deserve the protection of the business judgment rule. One problem with this analysis is that Litwin involved the directors of a bank, who are typically held to a higher standard of accountability than directors of other corporations. Another is that Litwin is a sport—a case that falls well outside the norm. It is cited so often, because it stands alone as plausible precedential support for the irrationality exception to the business judgment rule. Finally, consistent with our hypothesis that courts use rationality as a code word for self-dealing, the Litwin court found the transaction in question to be “so improvident, so risky, so unusual, and unnecessary as to be contrary to fundamental conceptions of prudent banking practice.” Although the court expressly declined to find a violation of the duty of loyalty, it seems fair to ask whether “we have reason to disbelieve the protestations of good faith by directors who reach ‘irrational’ conclusions?”[8]

In sum, it may be that there are some board decisions that are so dumb that the business judgment rule will not insulate them from judicial review.[9] Even if the set of such decisions is not an empty one, however, the tail ought not wag the dog. Because a prerequisite of rationality easily can erode into a prerequisite of reasonableness, courts must tread warily here. If they want to persist in requiring that there be a rational business purpose, at least they can ensure that that requirement lacks teeth.

The Restatement of The Geography of Revlon-Land

As regular readers know, I am working on several projects relating to the tentative draft of the restatement of the Law of Corporate Governance. As I've plowed through the draft, I noticed that the drafters touch in passing on the geography of Revlon-land.

Reporter’s Note 3 to Section 2.01 comments in passing on the issue of when Revlon duties trigger, suggesting that “when a corporation is sold for cash” and “all of the shareholders will be cashed out” “the board may not balance the interests of shareholders against the interests of other stakeholders. This is the clear holding of Delaware’s Revlon case and a long line of other cases.” It is true that Revlon clearly held that when Revlon duties have triggered, there can be no consideration of interests other than those of the shareholders.

The implicit suggestion that Revlon is always triggered by a sale for cash, however, is controversial. True, dictum in some Delaware Chancery Court decisions suggest that that all cash and some mixed consideration sales trigger Revlon.[1]I have elsewhere argued that those decisions are inconsistent with controlling Delaware Supreme Court precedent.[2] In my view, the relevant Supreme Court precedents clearly indicate “that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.”[3]

I have also argued that the Chancery Court dicta is inconsistent with the policy concerns that motivated Revlon.[4]The Chancery Court dicta is premised on the notion that Revlon is concerned with “whether there will be a tomorrow for the shareholders,” but Revlon was mainly concerned with whether the structure of the transaction allows the market to redress any conflicts of interest on the part of the target directors.[5] As long as the acquirer is publicly held, the conflict of interest concerns are muted and “diversified shareholders will be indifferent as to the allocations of gains between the parties. In turn, those shareholders also will be indifferent as to the form of consideration.”[6] It is that approach to Revlonduties that the drafters should restate.

Scalia on Restatements of the Law

I am working away at a couple of law review articles about the tentative draft of the Restatement of the Law of Corporate Governance. In doing so, a friend pointed me to a great quote from Justice Scalia:

[M]odern Restatements . . . are of questionable value, and must be used with caution. The object of the original Restatements was “to present an orderly statement of the general common law.” Over time, the Restatements' authors have abandoned the mission of describing the law, and have chosen instead to set forth their aspirations for what the law ought to be. . . . Restatement sections such as that should be given no weight whatever as to the current state of the law, and no more weight regarding what the law ought to be than the recommendations of any respected lawyer or scholar. And it cannot safely be assumed, without further inquiry, that a Restatement provision describes rather than revises current law.

Kansas v. Nebraska, 574 U.S. 445, 475–76 (2015) (Scalia, J., concurring in part) (citations omitted). I concur.

Do we need a Restatement of the Law of Corporate Governance? (No.)

In 1978, the American Law Institute authorized a project originally intended to result in a restatement of corporate law.[1] As the decade long process of reaching consensus on the corporate governance project dragged on, it became what is still one of the most controversial projects the ALI ever attempted.[2] Indeed, one highly respected commentator went so far as to describe the project as “the most controversial event in the history of American corporate law.”[3] Perhaps because of the controversy surrounding the project, it has had little influence on judicial development of corporate law.[4]

Despite this dubious precedent the ALI has returned to the corporate governance field with a proposed Restatement of the Law of Corporate Governance (Restatement).[5] At the ALI’s 2022 annual meeting, the membership considered Tentative Draft No. 1, which contained provisions defining various terms, discussing the duties of care and loyalty, and the social purpose of the corporation.[6] Except for one of the duty of loyalty provisions, the membership approved the draft.[7]

It is probably too late to stop the Restatement project from going forward. The ALI membership voted to approve the idea of a Restatement and subsequently voted to approve most of the first tentative draft. The project has three reporters, all well respected corporate law academics.[8] There are dozens of very prominent and very influential attorneys, judges, and academics acting as advisers to the project.[9] There are 170 ALI members serving as a consultative group.[10] So the project has a lot of inertia and a lot of powerful individuals with a stake in seeing the project come to fruition. Granted, the time and effort expended to date are sunk costs that logically should be ignored in deciding whether to continue the project, but people are not very good at ignoring sunk costs.[11] The train has left the station and is unlikely to be derailed.

Nonetheless, to borrow a phrase from William F. Buckley, it is sometimes necessary to stand “athwart history, yelling Stop,’ especially “when no one is inclined to do so, or to have much patience with those who so urge it.”[12]

Courts are the main audience for Restatements and, as such, their content is “generally common law.”[13] The purpose of a restatement is to clarify “the underlying principles of the common law” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, within the United States.”[14]

It is here that we come to the crux of the matter. Unlike most common law topics, corporate law is not troubled by the potential for confusion that arises when many competing jurisdictions are all contributing to the development of the law with more or less equal claims to authority.[15] The law of corporate governance, especially that applicable to public corporations, is dominated by a single Leviathan.

Delaware is home to more than half of the public corporations listed for trading on U.S. stock exchanges.[16]Delaware’s share of large public corporations is even higher, with almost two-thirds of Fortune 500 corporations.[17] As far as the larger universe of business entities is concerned, Delaware is home to over 1 million, which consistently places it in the top 5 states of organization.[18] Most business entities form under the laws of their home state, of course, but Delaware is the leading choice of businesses that opt to incorporate outside their home state.[19] Because of the generally accepted choice of law principle known as the internal affair doctrine Delaware law will govern corporate governance disputes regardless of which U.S. jurisdiction in which the dispute is litigated.[20]

Delaware’s dominance of the corporate law field is further enhanced because many state courts follow Delaware law when their own state law does not provide an answer to the question at bar.[21] They presumably do so because of Delaware’s widely acknowledged mass of high-quality corporate law.[22] Even federal courts may look to Delaware law for assistance in interpreting federal law, as the Third Circuit observed in a case interpreting Bankruptcy Code § 328’s requirement that indemnification provisions in employment agreements be reasonable:

We look to Delaware corporate law as a guide primarily because it offers time-tested insights on how courts should best evaluate an issue similar to the one before us. Additionally, Delaware's law often cues the market.[23]

Accordingly, a Restatement of the Law of Corporate Governance is unnecessary. Courts and lawyers will look to the well spring of corporate law for guidance, rather than the product of an unelected think tank whose drafters lack the powerful incentives to get it right to which the Delaware legislature and courts are subject.[24]

Accordingly, I quipped on Twitter that:

We don't need a Restatement of Corporate Governance. We already have one. Folk on the Delaware General Corporation Law: Fundamentals, 2021 Edition . . ..[25]

Either the Restatement of Corporate Governance will restate Delaware law (in which case who needs it) or it will not restate the law but rather propose changes (in which case it will be ignored).[26]

 

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Do Constituency Statutes Allow Consideration of Environmental Factors?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In a prior post, I addressed his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm. In this post, I address his criticism of the Restatement drafters' treatment of so-called constituency statutes.

The Restatement expressly splits out what it calls “stakeholder jurisdictions” from what it calls “common-law jurisdictions.”[1] Since Pennsylvania adopted the first constituency statute in 1983,[2] thirty states have adopted constituency statutes (a.k.a. non-shareholder constituency statutes or stakeholder statutes).[3] Although the details vary somewhat, the statutes generally authorize directors to consider various factors other than shareholder value maximization when making corporate decisions.[4] Massachusetts’ statute is typical:

(a) A director shall discharge his duties as a director, including his duties as a member of a committee: . . . (3) in a manner the director reasonably believes to be in the best interests of the corporation. In determining what the director reasonably believes to be in the best interests of the corporation, a director may consider the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.[5]

The Principles’ drafters did not address these statutes, instead relegating them to the comments, where the drafters opined that “it is clear that such statutes can be interpreted so as to be consistent with § 2.01.”[6]

In the Restatement, constituency statutes are promoted to the black letter law. Oddly, however, the black letter text of § 2.01(a)(2) suggests that in states with a constituency statute it is only licit for directors to consider the interests of various constituencies.[7] As even a cursory reading of the Massachusetts statute suggests, however, the name constituency statutes is somewhat of a misnomer. Massachusetts allows directors to consider such factors as the economy of the state or nation and “societal considerations,” for example, neither of which fit within a conventional definition of constituency.[8] Thirteen other states contain similar provisions.[9]

In contrast, § 2.01(a)(1) explicitly contemplates that directors of corporations in common law jurisdictions may go beyond the interests of the corporation’s constituencies to consider environmental and ethical concerns.[10] This difference led Professor Orts to complain that Restatement § 2.01 “misinterprets the legal import of corporate constituency statutes in a manner that unduly narrows the discretion of corporate directors and managers.”[11]

For example, “the environment” and “ethical considerations” are explicitly included as allowable decision-making factors in common-law jurisdictions but omitted in stakeholder jurisdictions (§ 2.01(a)).  Surely corporate decisionmakers in stakeholder jurisdictions may also take account of environmental and ethical considerations even if they are not specified as stakeholder interests.[12]

I respectfully disagree with Professor Orts’ reading of the constituency statutes. The factors most commonly authorized for director consideration by the statutes are the long-term interests of the corporation, firm profitability, growth prospects, employees, customers, supplies, creditors, and communities.[13] No state explicitly lists the environment as a factor directors are authorized to continue.[14] Only 10 states authorize directors to consider “any other appropriate factors,”[15] which may implicitly authorize consideration of environmental concerns. In this regard, the Restatement drafters got the law right.

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Can Directors Act Ethically Without Regard to Profit?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In this post, I address his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm.

The ALI's 1994 Principles of Corporate Governance  § 2.01(b) obliged the corporation to obey the law, allowed it to consider appropriate ethical concerns, and allowed to engage in philanthropic activities, in all cases even if doing do did not promote shareholder value or corporate profit. In contrast, in Restatement § 2.01, engaging in philanthropic activities is the only action expressly permitted “whether or not doing so enhances the economic value of the corporation.”[1] The framing by the Restatement’s drafters led Professor Orts to object that:

Allowing only an “economic objective” forces out any ethical or environmental consideration that does not technically qualify as a long-term economic rationalization.  The Restatement’s § 2.01 departs from the recognition in the Principles that ethical considerations may conflict with the economic objective, and that directors and officers may nevertheless follow their consciences in these situations.  (Principles, § 2.01 & cmt. h.)  Even Milton Friedman, a famous (or infamous) champion of the economic objective in business corporations, conceded that profit-seeking must “conform[] to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”  To employ an updated example, doing the right thing with respect to the climate emergency may require a particular firm (such as a big oil company) to sacrifice some profits even as calculated over the long term. The Restatement’s § 2.01 seems instead to require big oil companies to maximize their long-term profits even it means burning our planet beyond all recognition.  It seems also to require a corporation adopting an anti-racist personnel policy to justify it with an economic or “business case” rationale rather than an appeal to an ethics of mutual respect and equal treatment.[2]

It seems unlikely, however, that the drafters intended thereby to effect any substantive change vis-à-vis the Principles. Comment e to § 2.01, for example, states without limitation to specific jurisdictional types that “corporations may take into account their effects on the environment, as well as the social impact of their operations.”[3] Comment e also states that “the economic objective does not imply that the corporation must extract the last penny of profit out of every transaction in which it is involved.” Illustration 6 states that in all jurisdictions it would be licit for a corporation to adopt a mission statement committing the company “to creating a sustainable, low-carbon future, advancing equality and diversity, and fostering employee success.”[4] Illustrations 27 and 28 both involve hypothetical oil companies that voluntarily reduce oil production claiming that doing so will both save the planet and be profitable in the long term.[5] In both, the drafters conclude that § 2.01 is not violated.[6] Given that the business judgment rule almost certainly would protect an informed decision by the board that the reduction would produce sustainable, long-term profits,[7] Professor Orts’ concern seems misplaced.

 

Delaware Vice Chancellor Travis Laster versus Corwin Cleansing

Corwin cleansing is a corporate law doctrine providing that:

the “business judgment rule is invoked as the appropriate standard of review for a post-closing damages action when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.”¹³ The Corwin doctrine is premised on the view that, “[w]hen the real parties in interest—the disinterested equity owners—can easily protect themselves at the ballot box by simply voting no, the utility of a litigation-intrusive standard of review promises more costs to stockholders in the form of litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them.”¹⁴ The same is true of stockholders deciding whether to tender their shares, and the Corwin doctrine has been extended to these circumstances.

Morrison v. Berry, 191 A.3d 268, 274 (Del. 2018).

I was reading a new opinion by Delaware Vice Chancellor Travis Laster today (Goldstein v. Denner, CA No 2020-1061-JTL (May 26, 2022), in which VC Laster held that defendants were not entitled to Corwin cleansing. 

As I was reading, it occurred to me that I could not remember a Laster opinion finding that defendants were entitled to Corwin cleansing. Having a little time on my hands, I did a Westlaw search. I found 4 other cases in which Laster addresses Corwin cleansing defenses.

1. In re Columbia Pipeline Group, Inc., CV 2018-0484-JTL, 2021 WL 772562, at *36 (Del. Ch. Mar. 1, 2021)
2. Firefighters' Pension System of City of Kansas City, Missouri Tr. v. Presidio, Inc., 251 A.3d 212, 263 (Del. Ch. 2021)
3. In re PLX Tech. Inc. Stockholders Litig., CV 9880-VCL, 2018 WL 5018535, at *39 (Del. Ch. Oct. 16, 2018), aff'd, 211 A.3d 137 (Del. 2019)
4. Voigt v. Metcalf, CV 2018-0828-JTL, 2020 WL 614999, at *10 (Del. Ch. Feb. 10, 2020)

In every one of them, he found that defendants were not entitled to Corwin cleansing.

In sum, defendants are 0-5 in VC Laster's court on Corwin cleansing. Granted, it's a small sample. But I still find it rather curious.

One possible explanation is that cases in which Corwin cleansing is available are easier to dispose of and end up getting dismissed using oral bench opinions. In which case, the sample is simply a selection bias issue.

Congratulations to new Delaware Vice Chancellor Nathan A Cook

Chancery Daily announced:

The Chancery Daily notes that on Friday, June 3, 2022, Delaware Governor John Carney nominated Nathan A. Cook to serve as Vice Chancellor on the Delaware Court of Chancery. Governor Carney Announces Judicial Nominations. Mr. Cook graduated from the University of Virginia Law School, clerked for Vice Chancellor Noble, and spent his subsequent legal career focused on Delaware corporate litigation. Mr. Cook will fill a vacancy left by Vice Chancellor Joseph R. Slights III, who announced his intent to retire in January 2022 (TCD offers the retiring Vice Chancellor gratitude for his service and best wishes as he embarks on new adventures). 

Kudos.

Do we really need a Restatement of Corporate Governance?

Either the Restatement of Corporate Governance will restate Delaware law (in which case who needs it) or it will not restate the law but rather propose changes (in which case it will be ignored). But I'll be waiting. pic.twitter.com/XXCuzWgMhF

— Steve Bainbridge (@PrawfBainbridge) May 17, 2022

Actually, I already weighed in: The American Law Institute is going to try writing a Restatement of Corporate Governance. Again. Oh joy. https://t.co/YZfbMnmnkU

— Steve Bainbridge (@PrawfBainbridge) May 18, 2022

California trial court strikes down gender quota statute (SB 826)

The WSJ reports and provides a link to the opinion. The decision is entirely based on equal protection considerations. No discussion of the internal affairs issue.

Director independence inquiries vary by context

In Sciabacucchi v. Liberty Broadband Corp.,[1] Delaware Vice Chancellor Glasscock explained that the independence inquiry varies by context:

Where the independence inquiry relates to special litigation committees, it requires a showing of independence by the special litigation committee, having displaced the common-law presumption of director independence. . . .

The independence inquiry as it relates to demand futility arises in the context where the challenged directors are not themselves interested in the question posed in the demand, but are alleged not to be independent of those who are. Where the latter are fellow directors, the required demonstration appears to be the easiest for a plaintiff to clear, given the natural reluctance of directors to take the action demanded—ultimately, choosing to sue fellow directors. If . . . the difficulty of impartially assessing a demand to sue fellow board members (or to sue business associates, friends, family, etc.), is high, it follows that a plaintiff would find it easier to impugn a director's independence in the context of demand futility. Successfully impugning a director's independence with respect to voting on transactions, conversely, should be more difficult than challenging that same independence with respect to assessing a demand. The ultimate factual burden upon a plaintiff to prove a director's lack of independence at trial will vary accordingly. The important point is that the decision in question must be viewed in the context of the director's relationship and her ability, in light of that relationship, to apply her business judgment thereto. . . .

“Delaware law does not contain bright-line tests for determining independence but instead engages in a case-by-case fact specific inquiry based on” the facts. Facts submitted to rebut the presumption of independence should be reviewed “holistically, because they can be additive.” Plaintiffs seeking to show that a director was not independent must demonstrate that the director in question had ties to the “person whose proposal or actions he or she is evaluating;” ties so substantial that she could not “objectively discharge ... her fiduciary duties.” The inquiry is whether those ties were material such that they displace the impartiality of the individual director.

 

[1] CV 11418-VCG, 2022 WL 1301859 (Del. Ch. May 2, 2022).

Would a director be fully protected by relying on an astrologer or a psychic?

Keith Paul Bishop asks "May A Director Properly Rely On Her Rabbi?":

In prescribing the duties of directors, California Corporations Code Section 309 provides that a director is entitled to rely on information, opinions, reports or statements prepared or presented by "counsel, independent accountants or other persons as to matters which the director believes to be within such person's professional or expert competence".   While the statute makes no reference to religious authorities, it would appear to allow a director to rely on such persons so long as the director believes the matters were within their professional or expert competence.  For example, a director of a corporation that prepares kosher food might rely on a rabbi as to matters pertaining to kashrut.

DGCL section 141(e) is comparable, specifically providing that a director is "fully protected" by relying on such a person. Which made me wonder whether a director could get protection for replying in good faith on an astrologer or psychic provided the director believes the matter is within their professional expertise. 

Perhaps surprisingly (or perhaps not), I was unable to find an caselaw on point. I did find a law review article, however, which opined:

When the argument focuses on valuation and management hires well credentialed investment bankers, it is difficult to see how a court can “look behind” competently prepared valuations.114 Judges and commentators acknowledge that investment bankers make biased valuations with disconcerting frequency, but no one credibly suggests preferable alternative experts.

114 For a partial but quite useful summary of the problems and indeterminacies that investment bankers face in preparing fairness opinions, see Carney, supra note 41, at 533-35. For clear expression of the court's inability to second-guess substance as opposed to procedure, see, e.g., the PLI's 21st Annual Institution on Securities Regulation, supra note 34. In one colloquy, E. Norman Veasey, now Chief Justice of the Delaware Supreme Court, suggested that the board should “look behind what the (investment) bankers are telling it.” Moore et al., supra note 34, at 279. To Veasey's suggestion, practitioner Steven Volk replied that all a director could do is “to satisfy himself that this is a reputable banker of national repute,” and stressed that beyond that inquiry the director could only “go to a different discipline, he could hire an astrologer or some other mystic to cross-check the results.” Id. at 280. See also, Panel Discussion, supra note 40, at 601 (noted practitioner, Arthur Fleischer, responding to calls for investment banking standards of conduct by stating that he was “not clear on what (the proponent was) talking about” and that “(t)he key fact for the banker is to act sensibly: that is it, and there is not anything more.”) (emphasis added). See also id. (Panelists “had an argument in the hall after the first panel about what the word 'fair' means in these (fairness) letters, and we had no real agreement within the group.”).

Park McGinty, The Twilight of Fiduciary Duties: On the Need for Shareholder Self-Help in an Age of Formalistic Proceduralism, 46 Emory L.J. 163 (1997).

Delaware Amends Section 102(b)(7) to Allow Exculpation of Certain Officers without Fixing the Basic Botch Job

There are a number of pending amendments to the Delaware General Corporation Law. Perhaps the most interesting of which is the expansion of exculpation to officers, albeit in a rather limited way. Sadden Apps summarizes the bill:

Since its adoption in 1986, Section 102(b)(7) has authorized a corporation’s certificate of incorporation to contain an exculpation clause that limits or eliminates the personal liability of its directors for monetary damages arising out of breaches of the fiduciary duty of care. The protection from monetary liability afforded by Section 102(b)(7) historically has been expressly limited to directors, and not available for officers. In recent years, the prevalence of fiduciary duty claims against officers has increased significantly, particularly in the context of class action M&A litigation seeking monetary damages. In many instances, the same breach of fiduciary duty claims are brought against both directors and officers, and while directors are able to have such claims dismissed based on Section 102(b)(7) exculpation clauses, officers are not. In some circumstances, individuals that serve a dual role as both director and officer will have such claims dismissed in their capacity as a director based on a Section 102(b)(7) exculpation clause, but they will remain in the case and subject to liability in their capacity as an officer with respect to the very same underlying allegations.

The proposed amendments to Section 102(b)(7) seek to reduce (but do not eliminate) this imbalance in the treatment of directors and officers. Notably, the proposed amendments would authorize exculpation of officers only in connection with direct claims brought by stockholders, including class actions, but would not eliminate monetary liability of officers for breach of fiduciary duty arising out of claims brought by the corporation itself or for derivative claims brought by stockholders in the name of the corporation.

In addition, not all officers would be entitled to the protection of an exculpation clause. Rather, only the following senior officers may be entitled to the benefit of an exculpation clause: the CEO, president, CFO, COO, chief legal officer, controller, treasurer and chief accounting officer, as well as any other persons identified as “named executive officers” in the corporation’s most recent SEC filings. Moreover, the same exclusions from exculpation applicable to directors (i.e., liability arising out of a breach of the duty of loyalty, acts or omissions not in good faith, or involving intentional misconduct or knowing violation of law or transactions from which the director derives an improper personal benefit) also would apply to officers under the proposed amendments, other than the exclusion for liability for unlawful dividends, since only directors are authorized to declare and cause the corporation to pay dividends.

I assume that the bill is a response to Morrison v. Berry. In that case, the target company's defendant directors obtained dismissal of a class action seeking post-closing claims for money damages arising out of the sale of Fresh Market. The target had a 102(b)(7) exculpation clause, which precluded monetary liability for breach of the duty of care on the part of the directors. The court allowed care claims to go forward against the CEO and general counsel. Although I have not conducted a careful count, I have the strong impression that there has been an uptick in the number of deal-related class actions being brought against corporate officers. So I assume this amendment is motivated by a wish to preclude those claims.

It's not clear to me why the bill is limited to direct claims, given that directors also get protection in derivative claims. I assume the intent is to allow corporations to sue officers, but why allow shareholders to sue?

The unfortunate thing is that the legislature did not see fit to use this opportunity to correct the basic flaws with Section 102(b)(7). The exculpation statute has been aptly described as “an internally contradictory botch job.” Christopher M. Bruner, Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law, 41 Wake Forest L. Rev. 1131, 1155 (2006).

That the statute is intended to permit exculpation of care violations is obvious; care is not among the exceptions to exculpation. Beyond that, however, the relative meanings of, and interrelationship among, the various exceptions is far from clear--a problem that, given Delaware's influence in the field of corporate law, has propagated itself elsewhere. . . . Notably, as one Vice Chancellor would later put it, “its subparts all illustrate conduct that is disloyal,” as that term has traditionally been understood, rendering it difficult to ascribe distinct conceptual content to each of the exculpation exceptions. . . .

Neither the statute nor the legislative comment, however, offers any interpretive guidance with respect to the exceptions.

Failing to address these problems with the statute makes the proposed amendments a missed opportunity.

What is a Poison Pill? And Why do Corporations Use Them?

In April 2022, Elon Musk bought a ~9% stake in Twitter. In response, Twitter's board adopted a shareholder rights plan--more commonly known as a poison pill. In this video, I explain what a poison pill, how it works, and why companies use them. If you want even more information about the poison pill, my book Mergers and Acquisitions has an extended treatment. https://amzn.to/38Pkj06

New Article: "Why We Should Keep Teaching Dodge v. Ford Motor Co."

I have just posted a new article to SSRN: Stephen Mark Bainbridge, Why We Should Keep Teaching Dodge v. Ford Motor Co. (April 5, 2022). UCLA School of Law, Public Law Research Paper No. 22-05, Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4076182

Abstract

What is the purpose of the public business corporation? Is it to maximize shareholder value? Or is it to simultaneously enhance the welfare of shareholders, stakeholders, and the larger society? These are perennial questions, of course, but they also have been much in the news in recent years. Whether tagged as stakeholder capitalism, stakeholder theory, corporate social responsibility, or ESG (i.e., environmental, social, and governance), much attention is being paid.

The time has thus seemed propitious to many legal scholars to revisit the law of corporate purpose. Many of these scholars have been influenced by the late Lynn Stout’s work on the topic. Ten years ago, Stout published her book, The Shareholder Value Myth, which built on her earlier article, Why We Should Stop Teaching Dodge v. Ford. As the latter title suggests, Stout’s principal foil was the Dodge case.

Stout’s focus on Dodge was well chosen, as the case is included in almost all law school corporation law and business association casebooks and has been widely discussed in the academic literature. The influence of Stout’s critique of Dodge work was confirmed by a March 31, 2022, search of the Westlaw Law Reviews and Journals database, which identified 98 articles published in the last three years that cited her book and 43 during the same period that cited her article.

Given the renewed attention to the corporate purpose question and the continuing influence of Stout’s work on that debate, it seems appropriate to revisit her arguments to determine whether she was correct that law professors should stop teaching Dodge. I conclude that law professors ought to keep teaching Dodge. It was good law when handed down in 1919 and remains good law today.

Keywords: corporate purpose, corporate social responsibility, CSR, ESG, Henry Ford, Dodge v. Ford Motor Co., shareholder primacy, stakeholder theory, stakeholder capitalism, corporate law, shareholder wealth maximization, shareholder value maximization

JEL Classification: K22, L21, M14